So far this
have been driven by price-to-earnings (
) ratio expansion. That could change in the second half of the
Earnings Growth Could Add To Market Gains
have been coming in slightly better than expected. Nearly
two-thirds of companies reporting so far have beaten
Earnings per share (
for the S&P 500
are on track for 3.9% growth compared with a year ago. With
growth being so slow, many
are worried about a potential market decline. As usual, concern
grew when major indexes dropped from all-time highs last
After losing 1% last week,
S&P 500 (NYSE:
is still up about 23.5% on a total return
in the past 12 months. Total return has come from earnings gains,
dividends and an expansion of the P/E ratio. An expansion of the
P/E ratio occurs when the ratio rises, and some analysts have
been commenting that these market gains are of a "lower quality"
than earnings gains.
An example might be helpful to explain P/E ratio expansion. If
a stock earned $1 a share two years ago and traded at $10 a
share, the P/E ratio would have been 10. In the last year, we can
assume this stock again earned $1 a share but the stock now
trades at $12 a share and has a P/E ratio of 12. All of the gains
would be due to an increase in the P/E ratio, which is more
formally called a P/E expansion.
Dissecting the one-year total return for SPY, we see that:
-- Dividends account for 2.9% of the total return.
-- Ignoring dividends, SPY is up 20.6% in the past 12
-- Earnings growth accounts for 3.9% of the index price
-- P/E expansion accounts for 16.7% of the total return.
Based on trailing earnings, the P/E ratio of SPY is now at 16.
That is within the historical average range of 15 to 17.
Looking ahead, the question is whether or not P/E expansion
continue to help push stock prices up. I expect it will.
Standard & Poor's analysts expect
growth of 13.2% in the third quarter of this year and 25.8% in
the fourth quarter. For the full year, EPS is expected to grow
about 12% compared with 2012 and reach $108.50 in 2013.
To develop a
for the end of the year, we need to determine a reasonable P/E
ratio for the index given the expected rate of growth in
earnings. Since 1988, the 12-month change in EPS has averaged
about 8.3%. In 2013, we are expecting to see growth that is
almost 50% greater than average, and that should be rewarded with
a higher-than-average P/E ratio. The average range of the P/E
ratio has been 15 to 17. With higher-than-average EPS growth
expected this year, it is reasonable to expect a
higher-than-average ratio of 18 or 19 for SPY.
The table below shows several possible targets:
I prefer to target the higher end of the range. Assuming
companies meet expectations, the S&P 500 could trade at about
2,000 near the end of the year, a potential gain of about 18%
from the current price.
If the doom and gloom forecasters are correct and a
is on the horizon, a 20% drop in the stock market is certainly
possible. However, recessions develop over time, and markets
generally give signals that the
has ended. That is not happening right now. Given the size of the
possible gains, it seems best to stay invested in the stock
market until a reversal is confirmed.
Could Gold Bounce Back Quickly?
Gold is a unique
usually considered to be in a league of its own. However, gold
actually shares attributes with almost all other asset
With the introduction of exchange-traded
), gold trades like
. Years ago, gold purchasers took physical possession of bars or
coins. Transactions carried high costs, and gold was truly a
. That all changed when GLD and other ETFs made gold easily
tradable and reduced the costs so much that they are no longer a
This significant structural market change did not change the
fact that gold cannot be valued like a stock. Gold does not
to its owners, and the future prospects of the metal are based on
uncertain supply and demand estimates rather than
. Gold bulls believe the metal will rise in value usually because
they think of it as a
against global economic uncertainty. Bears believe that gold is,
in the words of the great
John Maynard Keynes, "a barbarous relic" that no longer serves as
an alternative to
in the modern world.
No one knows what the future holds, but in the past, gold has
traded more like a
than a stock. One key difference between the two
types is how tops and bottoms are formed.
In stocks, we often see a top form over time as prices trade
within a narrow range before falling. Stock market bottoms often
unfold in dramatic fashion with
signaling the end of the
and a sharp reversal upward in the next few days signaling the
start of the next bull market.
Commodities often show the opposite behavior. Tops are formed
in a panicked fashion as investors worry they are missing the
trend. This happened with gold in 2011. On the chart, the top
shows as a spike high and a rapid reversal. Bottoms take time to
form over months or years.
GLD has not formed a base, and a large price move to the
is unlikely without a base. For at least the next few months, I
expect gold to be "dead money" for long-term investors. But it
might be a good time to accumulate new positions as the base
This article originally appeared on ProfitableTrading.com:
Market Outlook: Stocks Could Add 18% to Gains
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